Will the US Fed risk a recession to tame inflation?
- Signs of an overheating US economy may push the central bank to raise rates more aggressively, on top of the need to bring its bloated balance sheet under control
- Unemployment will rise in a trade-off, but the question is by how much
The US Federal Reserve may be losing the battle of the Phillips curve, the inverse relationship between inflation and unemployment which can gauge whether the economy is running too hot or too cold.
Right now, the US economy is running the risk of overheating, with inflation hitting 7.5 per cent in January, and more than an outside chance that the headline rate could hit double figures this year, something not seen in America for over 40 years. At the same time, the US may be heading for 1950s-style unemployment, with the jobless rate possibly falling below 3 per cent this year.
By any standards, it looks like the Fed has fallen badly behind the curve and has some catching up to do, raising the odds that US interest rates will be hiked as soon as the next FOMC (Federal Open Market Committee) policy meetings on March 15-16.
Market expectations are centred on a quarter-percentage-point rise, but could the Fed surprise the markets with a bigger half-point move? It may be time for the Fed to take a gamble and gain an advantage over inflation before it runs out of control.
The Fed has run fast and loose with US monetary policy for so long, since the 2008 global crash, that it will be hard for consumers, businesses and investors to adjust to normality. They have become so accustomed to plentiful, cheap and easy money that there will be a reckoning for the economy when tighter policy takes hold.